Image: Accounting Income Method (AIM)

IRD’s marketing material boasts the accounting income method (AIM) means taxpayers only pay provisional tax when they make a profit.

But what it neglects to convey is what happens if an AIM user making a profit has no money in their bank account to pay tax when it is due.

The answer? Bad things. IRD charges interest and penalties – and there is very little they can do to mitigate the financial consequences.

Tax pooling, for instance, is not available to them. (We’ll explain IRD’s rationale as to why it isn’t further on in this article.)

Indeed, an issue with using accounting profit as the basis of AIM payments is it assumes a taxpayer has the necessary cashflow to pay tax.

As those earning income from business activity know, that is not always the case.

For instance, take a business that concludes the sale of a large piece of equipment and finishes installing it. They will derive the income for tax purposes at that time.

However, if the customer significantly delays payment or the terms of supply mean the customer will pay the price over many months, the business will not have the cashflow to pay provisional tax.

As such, they will incur steep IRD interest (soon to be 8.35 percent) and late payment penalties if they fail to pay the taxman on time.

Now if the taxpayer was using another method to calculate their provisional tax payments, they will have the ability to use tax pooling to make this payment when it suits their cashflow.

No worries. All good in the prov. tax hood.

But those using the accounting income method DO NOT enjoy this luxury. Legislation prevents them from using tax pooling. (Tax pooling can only help with terminal tax or reassessments if a taxpayer is using AIM.)

This hardly seems fair, does it?

Is it right IRD restricts the use of tax pooling for accounting income method taxpayers?

It was something the Tax Pooling Intermediary Association, of which TMNZ is a member, brought to officials’ attention when they were seeking submissions in 2016.

They felt the absence of any fallback mechanism such as tax pooling will put additional stress on taxpayers to pay a liability under AIM when they may not have enough cash.

“This type of situation is inconsistent with the policy intent of easing the burden on taxpayers and encouraging them to pay the right amount of tax at the right time without incurring penalties and could easily be mitigated by allowing tax pooling to be used with the AIM method.

“Feedback we have received from engaging with our SME clients is that the most important factor they have to deal with when paying taxes is cashflow.”

Chartered Accountants ANZ echoed similar sentiments in its submission, saying IRD’s analysis on AIM “ignores the cashflow element to a business”.

As an example, they cite a company that makes strong sales – but may not have the funds to pay provisional tax if debtors are not paying or if the owner is re-investing cash to grow the business.

“There is no reason to exclude AIM taxpayers from tax pooling.

“Tax pooling will enable the AIM taxpayer to meet their obligations without incurring IRD interest or penalties. Denying AIM taxpayers this flexibility at times when cashflow is tight is poor design.”

IRD’s position on AIM and tax pooling

In reply, IRD felt it was not appropriate for taxpayers to use tax pooling for AIM provisional tax payments.

That’s because payments under the accounting income method have certainty, more closely match the income flows of a business and have no exposure to IRD interest (assuming a taxpayer pays the amount due on time of course).

“The use of tax pooling for provisional tax payments throughout the income year provides certainty to taxpayers when payments are uncertain. It also assists in situations when provisional tax payments made under the estimate or uplift methods are not matched to the income flows of the business.

“Officials therefore believe that AIM effectively removes any benefit to a business from using tax pooling during the income year.”

They argue mismatches in cashflow to tax payments occur when tax adjustments move the taxable profit further away from accounting profit. Under the accounting income method, there is “minimal movement” away from accounting profit.

Moreover, IRD feels taxpayers could use their standard banking facilities if they have cashflow concerns.

If cashflow problems were to persist, they can choose to use a provisional tax method that better aligns with their cashflow.

“Pooling itself does not operate as a pure financial institution with regard to the short-term loans, rather it facilitates the sale and purchase of tax paid at different dates.”

However, the Tax Pooling Intermediary Association says pooling is more than just the sale and purchase of tax at different dates and IRD is missing the point.

 “Tax pooling has evolved … and is now used extensively by taxpayers as a cashflow management tool, to enable them to pay their income tax when cashflow from their business allows.”

The fact of the matter

Whatever someone agrees or disagrees with IRD’s stance, the fact remains the same.

Taxpayers using the accounting income method must be aware of the potential consequences they face if they are making profit but have insufficient cash to pay tax.

And as they cannot use tax pooling to defer AIM payments if they are experiencing a cashflow problem, they need to consider if it is the right option for them. It can also be quite a compliance-heavy method, especially for taxpayers with significant year-end adjustments.

In other words, do not take IRD’s marketing spin as gospel.